I recently opined, in this April 8, 2012 article, that I expected this looming Facebook (FB) initial public offering to be a train wreck for small, retail investors. I argued that Facebook would be coming to market amid a perfect storm of cheap money, irrational exuberance, and slap happy promotion. At the time, however, I never would have thought that Mark Zuckerberg would go rouge and inadvertently sabotage his own Facebook deal. The Facebook IPO, which The Wall Street Journal reports is set for May 18, will be marred by questions related to the company's baffling Instagram purchase and novel Timeline features that have effectively curtailed growth.
The Initial Public Offering
In May, Facebook will "go public," to raise equity financing for operations. Investors will receive shares that carry ownership and voting rights, in exchange for offering up cash to buy in to the business. After the IPO, Facebook shareholders can trade stock on the secondary market with other investors. Prices for these Facebook shares will fluctuate according to future earnings expectations for the firm.
This thing will be a spectacle of competing interests running amok to feed at the trough. In a tug-of-war, the Facebook Corporation and its insiders will angle for the highest price possible, while outside investors want to get in on the cheap and improve their potential for long-term gains. J.P. Morgan (JPM), Goldman Sachs (GS), and Morgan Stanley (MS), of course, have been hired to play traffic cop. The Big Banks will collect fees for taking this show on the road to drive up demand and allocate shares to regular folk.
For banks, or course, an IPO is "successful" when shares spike initially, only to collapse over the next week. To me, a "successful" IPO only means that shares were purposefully underpriced to manufacture bell-ringing excitement. At market closing, Facebook will have left money on the table, Fat Cats will cash out at the top, and mom-and-pop savers will be duped into holding a burlap sack full of toxic assets.
Greed is good, right?
Although reports indicate that Facebook will raise $10 billion - for a total $100 billion valuation for the corporation, I feel that management mistimed the market, and could have upped the ante even more. Facebook, had it gone public in 2011 or even Q1 2012, would have ridden the wave of the very same cheap money Web 2.0 bubble that precipitated the crash and burn of Pandora (P), GroupOn (GRPN), and Yelp (YELP). The Pandora case is especially egregious, as shares of this Internet radio company lifted off on its first trading session from $16 to $26, only to get shellacked and settle in at $8 over the next year.
Playtime is over; and seasoned investors are quickly losing patience with these social media outfits.
Instagram Purchase and Renegade Management
As was the case with Google (GOOG), blue blood investment firms and high-net worth individuals may prove themselves weary of throwing money at a bunch of wiz kids who engineer newfangled technologies. Facebook's dual class structure, of course, does little to allay fears of a fraternity house atmosphere where inmates literally run the asylum. Within Facebook's S-1, the firm details plans to award the bulk of its Class B shares to founder Mark Zuckerberg through outright immediate grants and future stock options. For Facebook, Class B shares carry 10 times the voting power of its Class A stock.
According to the filing, Zuckerberg will "control the outcome of matters submitted to our stockholders for approval." This young man has effectively granted himself license to run a publicly traded firm, as if it were a sole proprietorship. Although Zuckerberg is obviously a technical genius, the jury is still out as to whether our latest Golden Boy is ready for prime time on Wall Street. Our fear is that, similar to Michael Jordan in Charlotte, that this megawatt star will merely surround himself with yes-men cronies who will do his bidding - at the expense of winning results.
Although I would love to give Mark Zuckerberg the benefit of the doubt, I am still shaking my head, or as you hipsters would say, SMDH LOL, over Facebook's April 9, acquisition of photo sharing company Instagram for $1 billion. Three days earlier, Venture Beat had published a report valuing this Android application at $500 million. Call me a cynic, but Facebook brass agreed to pay $1 billion for a 13-employee business that clocked zero in revenue during its 18-month existence.
Either Mark Zuckerberg eyed Instagram as a threat, or this guy has gone rogue, and the cat is out of the bag. According to Forbes, the Instagram purchase, yet again, highlights cracks within the Facebook foundation. At any time, some nerd in a garage could set up shop, build out a site, and steal social media market share. Zuckerberg, of course, calls the shots, and may write checks at any time on a quixotic campaign to acquire outside technologies and run rival pipe dream firms out of business.
Meanwhile, as we were distracted by the Instagram deal, Facebook was force-feeding the unpopular Timeline feature down our collective throats and milking us for cash. In a clear sign of chutzpah, Facebook has ignored the bitter complaints of its user base to make this Timeline set up mandatory by year end. Instead of simple vertical scrolling by date, Facebook socialites must navigate through a hodge-podge of posts, random photos, and links that apparently follow no chronological order. The Atlantic Wire claims that this Timeline feature is simply another excuse for Facebook to saturate its pages with online advertising and book top-line sales.
Clearly, Facebook has pulled out all of the stops to monetize itself before this looming IPO.
The Bottom Line
On April 23, 2012, Facebook filed an amendment to its original S-1 registration statement with the Securities and Exchange Commission. This new paperwork has only exposed Menlo Park executives and their minions to increased scrutiny. In terms of earnings growth, Facebook is actually decelerating. For Q1 2012, Facebook posted 10 cents per share in earnings, compared with 12-cent EPS during the same period in 2011. Although top line revenue grew by 43 percent to $1.06 billion, net income was driven down due to an explosion in marketing and research and development costs. Granted, Facebook bankers can haughtily explain these concerns away as seasonal non-events within a small sample size of data. There is a case to be made that Zuckerberg is leveraging these up-front costs to realize increased long-term profits.
I would argue, however, that a corporation selling itself as a growth story has no wiggle room - for any short-term earnings gaffe. When the smoke clears, it is likely for Facebook to carry a $100 billion market capitalization over top of $1 billion in 2011 net income. These whisper numbers translate into a firm that trades for 100 times trailing earnings. For the sake of comparison, Apple (AAPL) share valuations have swung between 15 and 20 times trailing earnings, as this corporation averaged 65 percent annual profit growth over the past five years and took a helicopter lift to $600. Therefore, any Facebook earnings misstep, from here on out, would precipitate a stock price implosion and collapse toward zero.
Certainly, Mark Zuckerberg is smart enough to realize the gift and the curse of what is a publicly traded corporation. And we all got here, literally because we were looking for a place to meet girls.
Thanks, but no thanks, to the Facebook IPO.
Disclosure: I am long AAPL.